The dawn of cryptocurrency in divorce

 

Recent reports suggest that a growing number of divorce cases in the UK involve cryptocurrency, such as Bitcoin, as an asset listed by separating partners.

In some cases, there has been a suggestion that one partner is using cryptocurrency to hide assets from the other. In such cases, in theory, the court can order that digital forensic specialists are given access to relevant computers so that a search can be made for evidence of cyber-currency transactions in files, emails or browser histories. There are a number of difficulties that will be faced by those who are considering applying to the court for this type of search and seizure order.Specifically the courts will not be prepared to allow parties to undertake a “fishing exercise” and compelling evidence will, therefore, need to be adduced to support the contention that it is reasonable to believe that crypto-currency assets may not have been disclosed – mere suspicion will not usually suffice.

Furthermore, once an order has been made, the party benefitting from it will have to give careful consideration to how best to enforce it and to obtain physical custody of the computers or digital records in question. Another option worth considering is the appointment of a court receiver who can be given extensive powers to take control of assets of all types, but even a receivership will not be a panacea to the problems raised by virtual currencies.Matters are further complicated if one considers questions of jurisdiction. Imagine an amount of cyber-currency that is held in an e-wallet on an individual’s iPhone. Now suppose the individual has two phones both with a copy of the e-wallet, one of which is in England and the other in the United States. Is the currency in the UK or the US or both? There is probably no right or wrong answer to this.

In a family context, search and seizure orders are rare in the extreme and due to the innovative nature of cryptocurrency and its relatively recent invention, the courts are yet to be given specific procedures or powers to use when dealing with it. Indeed, even the simplest issues, such as legal ownership, are difficult to apply to virtual currencies. For example, it is generally the case that ownership of a crypto-currency arises by virtue of knowledge of what is called the “Personal Key”, which is simply a number with a large number of digits.

If one spouse shares the Personal Key with the other, or alternatively, if one spouse acquires knowledge of the Personal Key in relation to crypto-currency acquired by the other, it may or may not have become a joint asset, depending on the circumstances.

Having highlighted a number of ways in which crypto-currency presents unique challenges, it is important to reflect that it is in many ways similar to any other assets, be they gold bullion, cash or investments. On this basis, from the perspective of a forensic accountant, it should be no easier or harder to track down than cash. In most asset tracing cases, investigating accountants will start by finding the connection between the person and the asset.

Despite being cleverly masked, there is often a money trail that starts with the withdrawal from a bank account that funded the original acquisition of the cyber-currency. The difficulty in practice is that bank statements are often only disclosed for recent periods and if cyber-currencies were acquired long ago, it may be difficult to obtain the bank statements for the relevant periods.

If a person buys an asset using funds in a bank account, there will be a direct link between the bank account and the transaction, which forensic accountants can quickly identify. Matters become much more complex however when assets are bought for an individual by a third party to mask its purchase.

In the past it was common for unscrupulous business-owners to offer “discounts for cash”. Nowadays withdrawing or depositing large sums of cash causes suspicion but that is not necessarily the case with cyber-currency transactions. In theory a business-owner might offer “discounts for Bitcoin” or some such incentive to build up a stockpile of valuable crypto-currency that could remain hidden from a spouse or from HM Revenue & Customs (HMRC).

In cases such as these, transactions are typically traced not by following a money trail but by undertaking electronic searches of communications between the individuals suspected of collusion. Once again, the challenge will be to persuade the court to grant what will inevitably be considered draconian search and seizure orders. In some cases, such as Monero, digital currencies are purposefully designed to avoid tracking, while in other cases exchanges are located in jurisdictions outside of the law of England and Wales, making discovery and recovery even tougher.

It is easy to see why in recent years these forms of digital currency have become popular with the criminal underworld and why so many Governments and organisations are exploring new ways of regulating these systems. They tend to be torn however between a desire to restrict illegal activity and a desire, especially in the UK, to foster innovation within financial markets. Crypto-currencies may have a reputation as being the preserve of those seeking to undertake illegal activity but the Blockchain technology that lies behind it is likely to become an ever-more common feature of commercial transactions. Online retailers, for example, would like nothing more than to be able to transact with customers using a currency that enabled them to circumvent the banking system.

Ironically, despite its association with secrecy, the Blockchain basis of cryptocurrency means that in some cases it can be traced more easily than cash. If someone gives me a twenty pound note I have no way of telling where it came from. By contrast some cyber-currencies come with a built in audit “trail”.

Another important consideration is the volatility in the cryptocurrency world. The wide variation in the value of Bitcoin has been widely reported and it is quite possible that during course of the divorce process the value of cyber-currencies could vary far more than other, more stable assets. A final complication is that, if the marital assets include crypto-currencies, consideration will need to be given as to whether they are subject to a latent tax charge. The tax rules governing cyber-currencies are far from straightforward but in essence there are three possibilities. The first is that any rise in value is exempt on the basis that it is effectively a currency held in a manner analogous with the acquisition of foreign currency for the purpose of holiday expenditure, recognising of course that no one buys Bitcoin to pay for a hotel in Bitcoin Land!

The second possibility is that rises in value are subject to income tax. This tax treatment will apply if HMRC considers that the cyber currency transactions amount to “currency trading”. A third possibility is that there could be circumstances in which HMRC argued that an increase in value in cyber currency was a chargeable gain subject to capital gains tax. Of course all three treatments are predicated on the basis that the currency was within the UK and therefore subject to UK taxation. This, once again, raises the issues of jurisdiction mentioned above.

Finally, if there is evidence that cyber-currencies have been used to evade tax, one would need to consider whether there might be a risk of penalties which could be for up to 100 per cent of the tax (which could include VAT) and interest. Where a wallet or pool of cryptocurrency is discovered, or its existence is suspected, during an initial stage of divorce proceedings it is vital that legal advisers act quickly and work with forensic specialists to ensure that there is full disclosure and that appropriate steps are taken to preserve any assets that may be in jeopardy

Roger Isaacs, Forensic Partner at Milsted Langdon.

 Milsted Langdon is an award-winning Top 100 accountancy firm,. The firm has 28 partners and directors and more than 200 staff across offices in Bath, Bristol, London, Taunton and Yeovil.

Milsted Langdon is a member of MGI Worldwide, a top 20 ranked global accounting network with some 5,000 professionals in more than 250 locations around the world.

For more information about Milsted Langdon, please visit https://www.milsted-langdon.co.uk/

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