In a first for U.K. law authorities, the U.K. tax authority HM Revenue & Customs (HMRC) recently seized non-fungible tokens, or NFTs, linked to a purported value-added tax fraud case. The move demonstrates HMRC’s broadening focus from targeting traditional tax fraud towards addressing issues arising from the digital economy, in this instance linked to crypto assets.
In the last year we have seen HMRC issue significant guidance over the taxation of crypto assets, more recently on the growth of decentralized finance (DeFi—the provision of financial services, or arrangements supported by distributed ledger technology).
Much of the guidance HMRC has released thus far has focused on the income tax or capital gains tax issues that may arise, most commonly where an investor in crypto assets makes a disposal, or possibly even where an individual or a company is trading in crypto assets.
HMRC’s latest decision to seize NFTs in an alleged tax fraud case, however, suggests the investigation is linked to VAT and a significant number of companies.
How Do NFTs Fit Into the Crypto Tax Landscape?
It is important to first understand where NFTs may fit into the crypto universe, and what tax issues may arise regarding NFTs.
In the last couple of years, more clarity has been provided as to the U.K.’s tax position on crypto generally, though historically crypto has held the basic qualities of property in the U.K.
The U.K. capital gains rules set out that all forms of property are chargeable assets (save the odd exemption), so the disposal of crypto will most often trigger capital gains tax.
As with other aspects of the tax code, however, and linked to historical case law, where transactions in crypto—which can include NFTs—meet certain criteria (i.e. when held for a certain amount of time and/or with a profit-seeking motive, etc.), they may well amount to trading activity and potentially become taxable as trading income.
This is significant because trading income can be taxed at rates up to 45% whereas capital gains tax is only charged at rates of 10% or 20%.
It is also worth noting that in the last few years HMRC has been applying its information-gathering powers to secure data from a number of crypto exchanges on those holding crypto. This data may well be part of the genesis of HMRC’s investigation, although it has not confirmed this is the case.
NFTs and Value-Added Tax
A deeper analysis of an NFT may determine that rather than merely amounting to an asset (an intangible one as opposed to a tangible one), the NFT may well contain rights to other things, often services.
This is where the generally accepted analysis of crypto tokens as exchange, utility or securities is relevant. Bitcoin is an example of an exchange token, but often an NFT may be more akin to a utility token.
HMRC stated some time ago that a transaction of crypto (including an NFT) per se is outside the scope of VAT. However, the uninitiated will often be unaware that the services associated with the NFT may well trigger VAT.
Numerous changes have been made to VAT systems in recent times, including the tax location for the provision of services, particularly to address the provision of digital services. As with the income tax and capital gains tax codes, we would expect to see more guidance being provided in relation to VAT issues.
Furthermore, about a decade ago, there were significant challenges to VAT-levying governments as a result of VAT trader fraud (most commonly known as carousel fraud).
What Does this Mean for Those with Crypto Assets?
For a number of years commentators have warned those buying or selling crypto and NFTs to take great care that they are not investing in a financial fraud. This position is reinforced with tax advisers pointing out to these clients the risks of tax non-compliance.
There has been speculation that HMRC will adopt a soft compliance entry approach, while everyone tries to better understand the rules. However, this recent activity, although focusing on fraud (in which most individuals will not be involved), makes it clear that HMRC will act where the authorities see what they think is a person or persons deliberately flouting the rules.
Tax evasion is an indictable crime, and so associated NFTs may well amount to proceeds of crime, which, if the case, would in theory provide HMRC with the opportunity to seize the asset. It is also worth pointing out that assets seized in this way will unlikely be returned to the guilty parties, so their illegal activity might well be financially unproductive and also risk a custodial sentence to boot.
The digital economy is challenging many of the things we all understand, including in the tax world, and while the authorities are working hard to analyze and provide guidance as to their interpretation of the application of the tax rules to the crypto world, as with any other areas of doubt, in the years ahead we will need the courts to provide greater clarity.
There may be a need for a specific tax code for crypto, as opposed to the need to try and “fit” crypto into a predetermined tax position, created around a historic and more tangibly focused world. While the waters surrounding digital tax are still murky, it is more important than ever that those investing in crypto assets seek advice from suitably qualified tax advisers.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Gary Ashford is a Tax Partner (Non-Lawyer) at Harbottle and Lewis. He is also Vice President of the Chartered Institute of Taxation (CIOT) and Vice President of CFE Tax Advisers Europe.
The author may be contacted at: firstname.lastname@example.org