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Money for Nothing? Crypto-assets and their Implications in Matrimonial and Private Client Work

Helen Brander, barrister of Pump Court Chambers, considers the current treatment by the courts and taxation authorities of crypto-assets

 

Helen Brander, barrister of Pump Court Chambers.


For the matrimonial finance and private client lawyer, crypto-assets can form a major part of a client's estate and we are seeing them with increasing frequency. It is vital that we can identify, value and understand them, and advise on their implications for clients, for others interested in client assets, and to assist the court, if necessary.


Where are we now with crypto-assets?

Although crypto-assets were born as recently as 2008 with Bitcoin following the worldwide banking crash, fewer than 13 years later Bitcoin, Ethereum, Litecoin, Monero and similar crypto-currencies and tokens have generated surging interest. At the time of writing on 18th February 2021, according to XE.com, 1 Bitcoin (XBT) is worth £37,052, up from £7,802 just one year ago. On the same date, a Bitcoin exchange traded fund through Purpose Investments opened on the Toronto Stock Exchange, seeing almost seven million shares in the fund change hands before midday and almost ten million shares by close of trading.  Ethereum's value grew 750 per cent from January 2020 to January 2021 and the smaller currencies are also gaining value. Tesla and Paypal entrepreneur Elon Musk has spent the last week or so promoting Dogecoin via social media and other outlets, increasing its value as a result. Crypto-assets, although being completely intangible, are currently white-hot property.


Crypto-assets: currency, property or something else?

Crypto-assets began with the person or persons named Satoshi Nakamoto publishing a paper in October 2008 entitled Bitcoin: A Peer-to-Peer Electronic Cash System setting out a vision of commerce transacted between parties with cryptographic proof of transactions, rather than requiring those transactions to take place on trust or via a trusted third party, such as a bank. This is done by the creation of a distributed ledger of transactions which is held on computers around the world and is updated simultaneously on all copies of that ledger whenever a transaction is recorded in it. The ledger is called the blockchain.  A person holding Bitcoin or other crypto-assets has a public key (a string of electronic data visible in that ledger) and a private key (a string of electronic information confidential to them and which should be stored safely and away from the public key – preferably in a non-internet accessible mode (a piece of paper in a locked box is perhaps safest!)). To record a transaction on the blockchain where a person providing goods or services is happy to accept Bitcoin or similar in exchange, the purchaser combines their private key with their public key and directs the agreed share of Bitcoin (as any fraction can be transferred) to the vendor, who then also receives a fresh and randomly-generated private and public key, with the transaction being recorded on the distributed ledger / blockchain by the transferee authenticating the transfer. That transaction then becomes historic and cannot be revisited. If the purchaser of the goods retains Bitcoin, they then also receive a new private key and their public key will be modified. The identity of the person, company or entity holding crypto-assets on the blockchain are often not recorded and transactions take place by reference only to anonymous computer address identifiers. These are "on-chain" transactions. "Off-chain" transactions can also take place where, for example, someone transfers their private key to another outside of the blockchain. The new holder of the private key then has control over the asset.

It is now well-established that crypto-assets are considered in English law to meet sufficiently the relevant criteria to be defined as property, namely that a right in or affecting a thing must be:

(a) definable;

(b) identifiable by third parties;

(c) capable in its nature of assumption by third parties; and

(d) have some degree of permanence or stability (National Provincial Bank v Ainsworth [1965] AC 1175)

although the question of permanence or stability may remain moot, since a transfer of crypto-currency from one person to another, in fact, necessitates invalidation of the previous "holding" of it and creation of a new "holding", as the previous block on the blockchain which recorded the earlier transaction becomes historic, immutable and irreversible 1.  The UK Jurisdiction Taskforce noted, however, in November 2019, that the assets are as permanent as other conventional financial assets which only exist until they are cancelled, repaid, redeemed or exercised.

The effect of crypto-assets being defined as property is that an interest in them can be enforced against the whole world, as opposed to personal rights, which are enforceable only against someone who has assumed a relevant legal duty in respect of them.  If one has proprietary rights, they can be protected by injunctions, can be tracked down / traced, take priority over others asserting rights over the thing, and can be recovered where they have been unlawfully taken from the owner of the proprietary right.

To date, crypto-assets have been accepted as property and have afforded their owners proprietary remedies in England and internationally 2.  The lessons learned from these cases have been considered and expanded upon by Byron James and Andrzej Bojarski in their excellent Family Law Week article, Cryptocurrencies and Cryptoassets: Freezing Orders, Disclosure Orders and the Instruction of Experts, which includes useful proposed precedents for orders referred to in the title of that article.

Other jurisdictions treat crypto-assets, however, as currency, rather than property.  Italy, by legislative decree 90 of 2017 (amending the implementation of EU Directive 2015/849 (IV Anti-Money Laundering Directive)) imposed the same regulations on crypto-currency exchanges as apply to traditional money exchanges, thus treating those assets as a form of foreign currency, although they are defined as a "digital representation of value not issued by a central bank or public authority" and so are not declared by any recognisable authority as legal tender.

With their different definitions in different jurisdictions, crypto-assets are treated differently for legal and taxation purposes, and the private client and matrimonial finance lawyer is well-advised to bear this in mind and take appropriate local advice, particularly where the client has international interests.


Taxation issues

In England and Wales, HMRC has been active in assessing how crypto-assets might be chargeable to tax.  They have issued a paper which all lawyers dealing with such assets ought to consider. In short:

(a) crypto-assets held as a personal investment for capital appreciation in value are liable to capital gains tax upon disposal (including exchange of one crypto-asset for another) of those interests. Any transaction or transfer of value will result in a chargeable disposal at the transferor's marginal rate unless a relief or an exemption applies.

(b) Crypto-assets received from employers as a form of non-cash payment or from crypto-asset mining (crypto-assets awarded for verifying additions to the blockchain ledger), transaction confirmation or airdrops (where someone receives an allocation of crypto-assets as, for example, part of a marketing campaign or advertising, but where they do not receive them as a gift) are subject to income tax and national insurance contributions.

(c) Crypto-assets held by a deceased person form part of their estate and are relevant for inheritance tax.

(d) Where crypto-assets received as income per (b) above are disposed of, then they are treated as capital and gains / losses are taxed accordingly.

(e) Taxation of crypto-assets is based on the holder's residence in the UK. This is relevant for resident individuals who are non-domiciled for tax purposes. If crypto-currency is bought with gains made off-shore by someone making use of the remittance basis of taxation, then the crypto-currency transaction is considered remitted for UK tax purposes and charges arise.

(f) HMRC considered that it would be exceptional for individuals to buy and sell crypto-assets with a frequency, level of organisation and sophistication that amounts to financial trading.  In light of the creation of exchange traded funds, then that assumption may require revision.  If an individual engages in that activity, then income tax takes priority over capital gains tax and will apply to profits and losses, as it would be considered a business.

(g) Losing a private key (so losing the ability to access the crypto-asset and thus losing the asset itself) does not count as a disposal for capital gains tax purposes. If there is no prospect of recovering that private key, then a negligible value claim can be made, which, if accepted, means that the individual is treated by HMRC as having disposed of and reacquired the same asset (that they cannot access) so that a loss can be crystallised.

(h) Being a victim of fraud or theft of a crypto-asset does not amount to a disposal and the individual cannot claim a loss for capital gains tax. The individual still owns the asset and has a right to recover it. If someone pays for and receives crypto-assets which turn out to be worthless, they may be able to make a negligible value claim to HMRC.

(i) Individuals are well-advised to keep separate records for each crypto-asset transaction as crypto-asset exchanges may only keep records for a short period.

(j) Crypto-asset values must be converted into pounds sterling for inclusion on tax returns and the value methodology must be recorded and kept for consideration by HMRC.

(k) Crypto-assets cannot be used to make a tax-relievable contribution to a registered pension scheme as they are not considered to be currency or money.

Our clients who decide to hold and / or invest in crypto-assets are well advised to consider their tax position carefully. In general, gifts / disposals to spouses and family members will have the same tax consequences as transfers of any other property.


Orders and enforcement

Crypto-assets have appeared in lawyers' caseloads with increasing frequency, but what can one do with them? Sometimes, they form the most significant capital asset, or one party may receive employment income or incentives / bonuses in the form of a crypto-asset. How should that be treated?

As crypto-assets are property, property adjustment orders pursuant to s.24 Matrimonial Causes Act 1973 or property transfer orders pursuant to s.2(1)(c) Inheritance (Provision for Family and Dependants) Act 1975 may be made. This will be a chargeable disposal for capital gains purposes unless an exemption or relief applies.

Maintenance orders and legal services provision orders may be made where the holder of the crypto-asset is required to transfer a sum equivalent to a fiat currency sum, valued on the date of transfer, to the other party, or otherwise is required to liquidate a proportion of the crypto-asset equivalent to a fiat currency sum and to pay that fiat currency over to the other party (both of which will involve a taxable disposal). Accountancy advice should be taken as to whether for the payee this amounts to chargeable income, and / or whether for the payer the draw down or transfer to the other party should be treated on each occasion as a disposal for the purposes of capital gains tax.

In all circumstances where a person resident in the UK, but non-domiciled for tax, transfers crypto-assets to the other party of the court order, the parties and the court must be aware that the transfer itself will be taxable, even if the transaction at first glance takes place off-shore.

If a person anticipates that their registered legal partner or otherwise a trustee (constructive or express) is likely to dispose of their crypto-asset then freezing injunctions may be obtained.

If a person potentially liable to a duty to preserve the crypto-asset while litigation or negotiation continues does, in fact, dispose of it, then there are tracing firms such as Chainalysis, Elliptic and CipherTrace who can, by comparing movements in the public keys of assets and patterns, trace crypto-assets diverted by a party (or perhaps stolen by a hacker or blackmailer). Such orders can be made in conjunction with freezing orders. The reader should note that HMRC has invested and is further investing in tracing software and has requested disclosure of account holder information from crypto-asset exchange platforms, which those platforms are obliged to keep and produce to appropriate authorities. 

But what if the holder of the crypto-asset refuses or fails to comply with the order made?  If there are other assets held by the transgressor, then enforcement may take place against those assets. But if there are not, the aggrieved party is in an invidious position with the only apparent tools to hand being committal, appointment of a receiver where that might make a difference, or otherwise an order to obtain information from a judgment debtor. Although this may be a route to obtaining compliance with the order, it may be a fruitless exercise.

Legal policy makers and legislators urgently need to take steps to create a method of requiring a holder of crypto-assets to secure their private key in a neutral place to the satisfaction of all parties and the court, pending the outcome and satisfaction of litigation. While the holder of the private key has sole control, then the law, in its current state, is too insubstantial in its effect in the face of an unrepentant transgressor.


1 Note well, however, that the top six transactions on the chain are vulnerable to revision for a few hours until the distributed ledgers are fully updated and consensus is achieved.

2
See Vorotynseva v Money-4-Limited t/a Nebeus.Com [2018] EWHC 2596; Robertson v Persons Unknown (Unreported, 15 July 2019, Moulder J); AA v Persons Unknown who demanded Bitcoin on 10th and 11th October 2019 [2020] 4 WLR 35 (proprietary injunction granted); Quoine Pte Ltd v B2C2 Ltd [2020] SGCA(I) 2; Ruscoe v Cryptopia Ltd (in liquidation) [2020] NZHC 728.

2 March 2021