Businesses in the blockchain and cryptoasset space are increasingly looking to utilise digital currency and other cryptoassets as an alternative to or alongside other, more traditional employee incentive arrangements, such as share and option plans.
Cryptoassets have the potential to deliver significant value to employees in a form that is customisable to commercial objectives by creating an opportunity to coordinate value alignment between their employees and a decentralized network. But this form of incentivisation also raises complex questions about the legal, regulatory, and tax consequences of employees holding cryptoassets. These questions become only more acute when the company’s workforce is expanding globally. Many jurisdictions are still getting to grips with the tax treatment of cryptocurrencies and other cryptoassets, and the approach and level of certainty differs from country to country. The tax implications of crypto-based incentives in different jurisdictions should therefore be carefully considered before adopting a plan and granting awards.
The UK accounts for about 8% of the global crypto workforce and a third of the workforce in Europe.1 HM Revenue & Customs (HMRC) published guidance in 2021 setting out its view on the taxation treatment of cryptocurrencies and other cryptoassets, although significant gaps and uncertainties remain. The UK has not introduced a specific regime for taxing cryptoassets, instead choosing to apply existing tax rules to this new asset class. This means that the tax treatment can differ depending on the type of cryptoasset and the particular circumstances in which the cryptoasset is acquired, held, and ultimately disposed of.
Grant of Crypto-based Incentive Awards
HMRC guidance confirms that cryptoassets received as part of a UK employee’s income — including as part of an incentive award — fall within the definition of “money’s worth” for UK tax purposes; therefore, the value of the cryptoasset on receipt (net of any value paid by the employee) will be subject to income tax as earnings.
Under the UK’s current regulatory regime cryptoassets are divided into three main types and this categorisation has also been adopted by HMRC. Valuing the cryptoasset at the time of grant may be challenging depending on the type of asset being granted. ‘Exchange tokens’ such as Bitcoin, which have an indexed value, should be straightforward to value at the point of grant, but if the incentive award consists of ‘utility tokens’ (allowing access to goods or services on a blockchain platform) or ‘security tokens’ (providing rights or obligations similar to a share or debt instrument), these can be much harder to value at the point of grant and would likely require a specialist valuation.
Any tax liabilities arising at grant could create a dry tax cost for the employee. This may make a cryptoasset award less attractive, particularly given the pricing volatility of many cryptoassets. In a worst-case scenario, this could lead to a large up-front taxable value without any guarantee of future appreciation.
Care therefore needs to be taken to consider the timing of any cryptoasset award in the context of its market value to ensure it is an effective incentivisation tool for the company.
Readily Convertible Assets
Like any money’s worth receipt, getting the correct valuation to determine and account for the right amount of income tax is important from the employee’s perspective. It will also be a key issue for the employer company to the extent that the relevant cryptoassets are treated as “readily convertible assets” (RCAs) for UK tax purposes.
When assets that are given to employees under an incentive scheme are not RCAs, any income tax liability arising in respect of the receipt of that asset will be accounted for by the employee via their self-assessment tax returns. However, if the asset falls within the RCA definition, the tax liability will instead need to be accounted for by their employer through the pay-as-you-earn (PAYE) payroll system, and, in addition, there will be an obligation to account for employer and employee National Insurance contributions (NICs). The employer will then need to recover the amount paid on the employee’s behalf via deductions from other cash compensation payments.
The RCA definition is wide-ranging and depends on the facts and circumstances of the asset at the time of receipt. However, where the asset is tradable on certain exchanges or where there are, or are likely to be, trading arrangements in respect of the asset, it will fall within the RCA definition. This means that exchange tokens such as Bitcoin and other trading cryptocurrencies are likely to be RCAs, as will any other tokens in cases where trading arrangements exist at the time they are received by the employee.
Whether or not an incentive cryptoasset should be treated as an RCA will need to be considered on a case-by-case basis to ensure that any taxes arising at the time of grant are accounted for correctly and by the right person.
Currencies and Future Sale
UK employees who are granted cryptoassets as part of an incentive scheme will need to consider the UK tax implications of any foreign currency exchange fluctuations during the employees’ period of ownership. This can be a more complex exercise with certain cryptoassets such as NFTs, where the cryptoassets’ value may be denominated in another digital currency such as Ethereum, potentially making a double conversion necessary to determine their sterling value.
HMRC guidance makes it clear that a cryptoasset is a chargeable asset for UK capital gains tax purposes, meaning that gains on the sale of cryptoassets are taxable. Therefore, on ultimate disposal, a UK employee may be subject to capital gains tax on any value appreciation above the initial value of the cryptoasset at grant.
Phantom Token Awards
Given the complexity around cross-border grant of cryptoassets to employees, an alternative route may be to grant phantom crypto incentive awards to UK employees. Similar to a phantom share or share option award, a phantom cryptoasset award would provide the UK employee with incentivisation based on the future value of an identified cryptoasset but without physical grant of that asset.
The grant of a phantom cryptoasset award would not result in the day-one valuation or dry tax concerns that are outlined above. However, any future returns on crystallisation of the phantom award would be taxed as employment income and would attract employer and employee NICs liabilities. Companies therefore need to balance the potential up-front tax costs and complexities of granting cryptoassets against the additional tax costs of flipping to a phantom cryptoasset plan.
Beyond the UK
This summary considers only the potential tax considerations on grant of crypto asset awards to employees in the UK. Where groups are expanding into other countries in Europe and considering granting crypto asset incentives to local employees, the rules will need to be reviewed in each relevant jurisdiction because valuation metrics, taxing points, and applicable rates will differ from country to country.
[1] Vetle Lunde, “The U.K. accounts for 1/3 of crypto employment in Europe,” K33, 30 July 2023.
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