The tax treatment of lending and borrowing on decentralized finance (DeFi) protocols could soon be changed in the United Kingdom as the taxation arm of the Treasury is seeking input on a possible new regime.
An April 27 consultation by HM Revenue and Customs will run until June 22 and asks for “investors, professionals and firms engaged in DeFi activities” along with representative bodies and think tanks to submit their views on the government's proposed DeFi tax treatment.
Under the proposed legislative changes, crypto used in DeFi transactions wouldn’t be treated as a disposal for the purposes of tax which usually trigger a Capital Gains Tax (CGT) event.
Instead, CGT would apply — and a taxable event would occur — when cryptocurrencies are disposed of in a non-DeFi transaction.
A summary of scenarios and their proposed tax implications. Source: gov.ukAccording to the consultation, a transaction must meet certain criteria to be considered a DeFi transaction.
Specifically, it should involve the initial transfer of crypto assets from a lender to a borrower, or through a smart contract, with the borrower being obligated to return the tokens.
HMRC Update on DeFi Guidance
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Additionally, the lender should have the right to withdraw the same amount of tokens that were initially lent or staked.
The aim of the consultation is to establish a framework that “better aligns” the taxation of cryptocurrency assets used in DeFi lending and staking transactions while making it easier for users to comply with the regulations. It noted:
“To reduce the administrative burden for participants, the new tax framework could treat all DeFi returns as being revenue in nature and charged to a new miscellaneous income charge specific for cryptoasset transactions.”The consultation is the second stage of a five-step process, which will be followed by drafting legislation, implementing and monitoring, and ultimately, reviewing and evaluating the change.
Related: UK includes crypto investments under the Investment Manager Exemption
The British government took the first step in the process in July 2022 by soliciting feedback on the taxation of crypto asset loans and staking within the context of DeFi.
Simplifying the administrative process was again noted as the main objective as well as reducing costs for taxpayers participating in DeFi while also exploring how the tax treatment could better reflect the economic substance of these transactions.
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