The HMRC is requesting input on DeFi tax

In July, the HMRC put out a call for evidence pertaining to the taxation of DeFi activity. In their own words, the HMRC is striving to “ensure the UK financial services sector remains at the cutting edge of technology, attracting investment and jobs and widening consumer choice.” As a result of them wanting to stay ‘crypto-friendly’, they’ve requested feedback on whether administrative burdens and costs could be reduced for taxpayers engaging in DeFi activity, and whether tax treatment could be improved to better align with the economics of the crypto space.

They’ve specifically requested input from investors, professionals and firms engaged in DeFi activities including technology and financial service firms; trade associations and representative bodies; academic institutions and think tanks; and legal, accountancy and tax advisory firms. Basically, even if you’re an individual partaking in DeFi activity, you can and should have your say!

Current tax treatment of DeFi by the HMRC

In the UK, the tax treatment of lending or staking crypto assets on a DeFi platform is determined by whether or not there is considered to have been a change in beneficial ownership in the transfer of crypto assets. Depending on the underlying mechanics of the DeFi protocol, there may or may not be a change in beneficial ownership when actioning particular transactions. If a change in beneficial ownership is seen to have occurred, then it is usually treated as a disposal for capital gains tax purposes.

A large proportion of the DeFi industry focuses on the processes of lending and staking. Under the current taxation rules in the UK, any interest earned from lending or staking crypto assets on DeFi platforms will be subject to income tax.

As to the tax consequences of repaying a DeFi loan or withdrawing one’s staked assets, it once again depends on whether the beneficial ownership in the assets was transferred at the beginning of the activity. If there was, then repaying or withdrawing these same assets will likely also constitute a disposal event.

Proposed new tax treatment of DeFi by the HMRC

Option 1: Redefine crypto assets as ‘securities’. This would mean DeFi activity that met specific statutory rules would be included in the repo and/or stock lending guidelines, and would be excluded from CGT treatment.

Option 2: Creating a separate set of rules for DeFi activity. If evidence was collected that showed that Option 1 would have detrimental effects on the development of the DeFi market, or would not be sufficient to cover the variety of DeFi models that exist, or would create further issues for users, then there is a proposal that DeFi lending and staking activities be able to follow the principles applicable to repos and stock lending. This would remove capital gains tax from being applicable to some DeFi activity.

Option 3: “No gain, no loss”. The third and final option proposed by the HMRC: where the transfer of crypto assets for lending and staking purposes would be seen as a ‘no gain, no loss’ transaction. This treatment would mean that the capital gains would only come into effect when the crypto assets in question are disposed of in a non-lending or staking transaction.

Want to have your say?

So, you’re a UK taxpayer who wants to have their say on the matter? Now’s your chance! The call for evidence is open until the 31st of August, 2022 so get in quick. To submit a response, answer the questions on this webpage and send them by email to [email protected]. Make sure that when you’re sending your answers through to clarify if you’re a business, an individual or a representative body.

Disclaimer: The content of this guide is for general informational purposes only. It is not legal or tax advice. Viewing this guide, purchasing or using Crypto Tax Calculator does not create an attorney-client relationship or a tax advisor-client relationship.

The information in this guide represents the opinions of experienced crypto tax professionals; however, some of the topics in this guide are still subject to debate amongst professionals, and tax authorities could ultimately release guidance that conflicts with the information in this guide. The information contained in this guide is based on the authors’ interpretation of current guidelines. Changes to the guidelines may be retroactive and could significantly alter the views expressed herein. Therefore, use this information at your own risk and for information purposes only.

Consult a professional regarding your individual tax or legal situation.