The rise of cryptoassets has brought about complex regulatory and tax challenges for businesses and policymakers worldwide. One such challenge is the application of VAT to cryptoasset custodial services in the UK. Given that custodial services form an integral part of the cryptoasset ecosystem, understanding how these services interact with the VAT rules is crucial for service providers and their clients.

What are cryptoasset custodial services?

Users own and manage their cryptoassets through wallets. Generally, wallets are either custodial or non-custodial. Custodial wallets are wallets in which a third party holds the user’s private keys. Non-custodial wallets are managed by the users themselves, and the users keep control of their private keys. Cryptoasset custodial services involve the safekeeping and management of cryptoassets on behalf of clients. They can be provided by centralised entities, such as cryptoasset exchanges, financial institutions, or specialised custodians, who store private keys and facilitate transactions. 

Given the nature of these services and their comparison to custodial services in the financial assets space, the question arises whether they could be treated as a service connected to financial supplies and, therefore, potentially exempt from VAT. In addition, due to their digital nature, one must also consider the application of the electronically supplied services rules.

HMRC’s approach to VAT and cryptoassets

HMRC has issued limited guidance on the VAT treatment of cryptoassets (eg, in the cryptoassets manual, starting at CRYPTO45000), however, the application to custodial services remains somewhat ambiguous.

The UK currently follows the Court of Justice of the EU (CJEU) ruling in Skatteverket v David Hedqvist C‑264/14 (Hedqvist). This determined that the exchange of bitcoin for fiat (government-backed currency, eg, US dollars) and vice versa, is exempt from VAT under the exemption for certain financial services. Interestingly, neither the CJEU in Hedqvist, nor HMRC in its guidance, has specifically commented on the VAT treatment of transactions involving the exchange of cryptoassets for cryptoassets. Custody services, in isolation, do not directly involve the exchange of cryptoassets to fiat, raising questions about their VAT treatment.

There is also the question of when custodial services are packaged with other services (ie, can they form a single indivisible exempt supply?). Where this is the case, it may be possible for the VAT treatment applied to the actual exchange of cryptoassets to extend to the custodial services. 

EC VAT committee guidance

Although it does not serve as a binding authority in the UK, the European Commission’s VAT Committee has addressed the topic of cryptoasset custodial services in working papers 892 and 1037 and the applicability of the exemptions provided for under Article 135(1)(e) and (d) of the VAT Directive (ie, the financial services exemptions). The Committee suggested that, from a VAT perspective, it is largely irrelevant whether a wallet is hot or cold (see box). What is relevant is whether the services are provided for a fee and the nature of the services themselves.

The following comments from Working Paper 1037 may be persuasive in the application of UK VAT:

• Article 135(1)(e): “The services supplied by digital wallet providers directly concern means of payment within the meaning of Article 135(1)(e) of the VAT Directive – specifically, the making available of cryptoassets to users – and create rights and obligations in relation to the means of payment. Therefore, the application of the exemption pursuant to Article 135(1)(e) of the VAT Directive could be justified.”
• Article 135(1)(d): “For the exemption to be applicable, the supplier’s responsibility must not be limited to mere technical aspects and not extend to specific, essential elements of the financial transactions at issue. It is pointed out that digital wallet platforms connect cryptoasset users and the miners whose task it is to verify transactions between users, but supplying this service does not in itself entail any change as regards the ownership of the funds, no matter how necessary the service may be for the cryptoasset transactions to take place. The paper therefore concludes that taxable services supplied by digital wallet providers in exchange for consideration could not fall within the exemption pursuant to Article 135(1)(d) of the VAT Directive.”

Potential UK VAT implications for custodial services

VAT Notice 701/49 discusses custody services in context of securities and related services. HMRC breaks this down into two categories: 

• Safe custody (taxable): These services include the provision of the purely physical service of safekeeping, sometimes referred to as safe deposit facilities. 
• Global custody (exempt from VAT): Global custody services are a package of services that may include safe custody, the collection of dividends or interest on securities held, dealing with scrip and rights issues and payment against delivery of stock.

Custodial services could potentially qualify for the VAT exemption if they are considered “financial services” by HMRC. This would depend on the package of services offered by the custodian, for example, providing services to allow the user to sell/trade their tokens. The exemption primarily applies to transactions concerning currency and securities, so similarities could potentially be drawn with the custody of exchange/security tokens. There would, however, need to be consideration of the VAT treatment of security tokens and whether it meets the definition of a financial security.

This would also leave the VAT status of custodial services uncertain for other tokens. While the VAT Manual (VATFIN2330) does discuss the possibility of related charges being treated as exempt, it was last updated in 2020 and it is not clear whether HMRC’s position will extend to cryptoasset custodial services and the extent to which it could then extend to any tokens beyond exchange tokens.

Where the custodial services provided are considered akin to general data storage or security services rather than financial services, they could be subject to the standard 20% VAT rate if the recipient is based in the UK.

Furthermore, consideration of the place of supply rules is also essential. If custodial services are provided to a business (B2B) outside the UK, VAT may not be chargeable in the UK. However, service providers will still need to consider the application of the reverse charge procedure in the local jurisdiction. For B2C transactions involving non-UK customers, the VAT liability may depend on the specific jurisdiction’s VAT rules, triggering various VAT registrations overseas.

Compliance challenges and considerations

Given the lack of uniformity in VAT treatment worldwide, businesses providing cryptoasset custodial services must carefully assess the following:

• Jurisdiction-specific VAT rules: Understanding whether a specific country classifies custodial services as financial, security or data storage services (or a mix) is crucial for determining VAT obligations.
• Place of supply rules: Different jurisdictions have different approaches to determining where a service is supplied for VAT purposes, affecting whether VAT is chargeable.
• B2B v B2C distinctions: Many VAT regimes differentiate between business-to-business (B2B) and business-to-consumer (B2C) transactions, impacting VAT applicability.

Uncertainty remains

Ultimately, the UK VAT treatment of cryptoasset custodial services remains an area of uncertainty. While exemption may apply in some cases, certain custodial services could also be considered taxable at the standard rate. In addition, given the differences in VAT rules worldwide, businesses must be mindful of the risks and take a jurisdiction-specific approach to compliance.

As regulatory frameworks evolve, it is crucial for custodial service providers to stay informed of legislative developments and engage with tax professionals to ensure compliance. The VAT treatment and place of supply rules will be essential to consider, both in the country where the supplier is based as well as the country in which the recipient is based. 

Similarly, business recipients of cryptoasset custodial services also need to be aware of the specific risks, as this may impact the applicability of any reverse charge mechanism, as well as their entitlement to input tax recovery.

Royce Adcock (BDO LLP) and Ishvinder Bedi (BDO LLP), with assistance from Dion Seymour (Andersen LLP) and Cliff Mensforth (Grant Thornton UK Advisory & Tax LLP).