Could HMRC action on NFTs deter scammers?

Non-fungible tokens (NFTs) are one of the fastest growing markets in the world. The amount of cryptocurrency transferred in transactions was 415 times more in 2021 than the year before. Research indicates the popularity of the NFT market spiralled upwards, particularly in the last six months of 2021.

But what are NFTs, and why are they so popular? Many will be familiar with cryptocurrencies and their aim to replace traditional currencies with a digital version. NFTs are a different form of cryptoasset which represent the ownership of a unique item, such as a piece of digital artwork, music or perhaps a virtual home in the metaverse.

NFTs’ popularity and the sudden rise in their value might be partly explained by the innate desire for us to collect things. It is undoubtedly easy to copy a digital image, but an NFT is like a digital certificate of authenticity that provides ownership. While we can all buy a poster of our favourite artwork, a collector might pay a great sum for the original. The same principle applies to NFTs in the digital world.

However, there is a murkier side to this world and recent analysis by the blockchain research group, Chainalysis, highlights that the NFT market is being abused by scammers and money launderers.

One tactic employed by those looking to take advantage of the booming NFT market is known as “wash trading”. This involves an individual selling an NFT to another account that they have helped to fund or also control. It therefore appears to a third-party that the NFT has been increasing in value from a series of trades that have been artificially manufactured, resulting in them paying an inflated price.

If such scammers are based in the UK when they undertake these “wash trades”, they could be in for a nasty shock if HMRC catches up with them. There is very limited guidance from HMRC on NFTs but, in general, an individual cannot dispose of an asset to themselves. An artificial disposal from one wallet to another owned by the same person may not have substantially adverse UK tax implications, other than potentially incurring high transaction costs that would not be tax deductible against any genuine disposal in the future. Legislation in the UK and elsewhere to deter such activities would help provide protection to NFT investors.

If the scammer uses someone else’s digital wallet rather than their own to facilitate the artificial sale, then that could trigger a capital gains tax liability. From the analysis undertaken by Chainalysis, there are some professional operations undertaking “wash trading”. It is probably reasonable to assume that, if they are prepared to engage in unscrupulous activities like this on a large scale, meeting their tax reporting and payment obligations may not be high up on their agenda. Hopefully the news of HMRC’s seizure of NFTs will give scammers pause for thought.