Digital assets: How are they dealt with on divorce?

Digital (or crypto) assets now form part of many people’s financial portfolios. They are commonplace and many are routinely investing in digital assets to diversify their investments. Recent reports have indicated that one in ten people in the UK have some form of crypto asset. The role of the metaverse in the future in how people hold digital assets and how people interact around their digital assets is ever changing. Digital assets are increasingly subject to financial disputes between couples when they divorce and it requires a good understanding of how they work to unravel issues relating to quantum, value and accessibility.

Whether an individual’s digital assets are substantial or modest it is important that family lawyers are able to advise divorcing couples as to how digital assets will be treated by the courts upon divorce. Understanding and awareness of the law surrounding digital assets is essential to enable us to best protect our client’s interests.

The law

The Law Commission recognises that the increasing use of digital assets for an expanding variety of purposes means that the laws that govern or potentially govern their use and disposal need to be reviewed.

In August 2022 the Law Commission published its recommendations and the public consultation ran until November 2022. We are awaiting the outcome of the consultation but the report made a fundamental and important recommendation which could significantly impact the approach of the family courts: this is the creation of a third category of assets.

As it stands, the law divides assets in to two main categories:

• things in possession: objects which are tangible, moveable and visible (the majority of assets to be dealt with on divorce usually fall into this category: property, business assets, cash, etc.);
• things in action: personal property which can only be claimed or enforced through legal action: for example, debts, shares, right to be sued, etc.

The report recognises that the courts of England and Wales have been increasingly willing to conclude that digital assets can attract personal property rights, which in turn impacts how they are treated upon divorce or separation.

The Law Commission recommended that an explicit third category for digital assets should be established which would include property with the following characteristics:

• composed of data in an electronic medium (for example computer code, digital signals etc.);
• exist independently of persons and legal systems; and
• be rivalrous, meaning the use by one person necessarily prejudices the ability of another person to make the equivalent use of the property.

The Law Commission have indicated that they will be publishing further findings in 2023 and we await the outcome. In the meantime there is little by way of reported family cases dealing with digital assets but we can refer to other litigation cases for assistance. The case of AA v Persons unknown [2019] demonstrates the court’s willingness to treat these assets as property for the purposes of transfer, injunctions etc. There appears to be no reason why the same should not apply in a family law context.

Issues and questions arising for our clients in relation to digital assets

Until we have changes in the law and the definition of digital assets, the family courts have to apply the existing law to this new category assets. As family lawyers we have noticed a number of the same questions arising again from clients both with digital assets and those who suspect that their spouse has digital assets. These include:

Do digital assets need to be disclosed as part of divorce proceedings?
Yes. Both parties have an obligation to provide full and frank disclosure of all assets in which they have a legal or beneficial interest in.

How are digital assets valued as part of divorce proceedings?
As part of the financial disclosure process, individuals must provide a full account of any digital assets they hold, whether this is crypto currency, NFTs, or other tokens or assets. This needs to include details of the size of the holding, the current value, any applicable tax or charges, together with documentary evidence of what is held and the assets current value.

What about market volatility?
The digital asset market is in the news daily on account of the substantial fluctuations in the markets. We are constantly reminded of the big winners and big losers in the market. As family lawyers, we are used to dealing with changes in the value of assets as part of the ongoing negotiations upon divorce. For example, individuals with shareholdings, business assets, and property assets often experience fluctuations in value throughout the negotiations or court proceedings.

It is usual for updated valuations to be sought at regular intervals as part of the ongoing negotiations, or the court process where parties are required to provide updating disclosure before a hearing. This ensures that the parties, their lawyers, and the judge are working with the most accurate and up to date figures when making decisions.  In the same way, digital assets will need to be updated throughout the process.

If you are concerned about the level of fluctuations and risk you are taking on by retaining or receiving digital assets as part of the overall settlement of the case then this is definitely something to discuss and receive advice on. It is important that any risk element of the assets following a divorce or separation is considered when dividing the assets. For example, you may be taking on a significant economic risk if you were to retain mostly digital assets, if your spouse is retaining mostly traditional cooper bottomed assets. This risk should be carefully considered with the implications of market volatility explored during the negotiations to ensure a fair outcome is achieved.

Are digital assets taxed?
It is paramount that the parties and the court understand not only the current market value of assets but also the net value of assets. This is an important part of the negotiation process, whether the assets are to be retained, transferred between the parties, or sold. Digital assets are no different.

In summary, the following rules currently apply to digital assets:

• Capital gains tax: HMRC treats digital assets, such as crypto currencies like Bitcoin, Etherium etc in the same way as shares, rather than as currencies. This means that they are subject to the same capital gains tax (CGT) charges as gains or losses on shares would be.
• Income tax: HMRC has confirmed that any individual trading digital assets in ‘exceptional circumstances’ and/or large sums would be considered to be a ‘trader’ and they would be liable to pay income tax at the usual rates for any income they receive. This also needs to be explored on a case by case basis.

The appropriate type and level of taxation applicable needs to be carefully considered as part of the divorce disclosure process. The last Autumn Budget, which took  effect on 6 April 2023, introduced additional relief from CGT for couples who are transferring assets as part of a financial settlement. However, it remains essential that any tax triggers are understood and taken into account when calculating the net effect of a financial settlement.

How can I cross check the disclosure of digital assets?
Many people have concerns about disclosure of digital assets. It is important that if you or your spouse have digital assets you find a family lawyer who has some understanding and experience in this area and knows what questions to ask and disclosure to look for. This is something that our family team and lawyers in other practice areas are able to advise on.

The confusion and complexity that continues to surround digital assets in family law is raised further by the lack of clear guidance: it is hoped that with time and the development of the law in the courts and the progression of the Law Commission’s recommendations we will have further clarity in the future.

If you are separating from your partner and either of you hold digital assets then you should seek legal advice as soon as possible. We have experience in representing clients who both hold digital assets and who have spouses who hold digital assets, and the approach of the family courts. Colleagues from our private client, tax, corporate and litigation team can also assist.

One of Penningtons Manches Cooper’s digital asset specialists, Charlotte Hill, has acted in proceedings involving the protection of cryptocurrency. She comments: “The English courts have for some years now recognised digital assets as property. The courts are therefore ready, willing and able to take decisive action if there is a risk of dissipation to protect those assets and to ensure that they are not put outside the reach of those entitled to them.”

Similarly, if you are at the outset of your relationship and want to know where you stand in terms of protecting your assets, including digital assets, then please do not hesitate to get in touch to see how we can help. You should seek advice and consider whether a pre-nuptial or post-nuptial agreement is appropriate to protect your digital assets now and in the future (particularly if you are expecting a windfall).

Should you have any questions regarding yours or your partner’s digital assets now or in the future, then you can contact either Rachel Donald or Eleanor Moodey to explore your options. 

Written by Rachel Donald and Eleanor Moodey from Penningtons Manchies Cooper.