UK Treasury seeks input on taxation of DeFi stakes and lending

The tax treatment of lending and borrowing on decentralized finance protocols (DeFi) could soon change in the UK as the tax arm of the Treasury seeks input on a possible new regime.

An April 27 consultation by HM Revenue and Customs will run until June 22 and asks “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 processing.

Under the proposed changes to the law, crypto used in DeFi transactions will not be treated as a disposal for tax purposes, which usually triggers a capital gains tax (CGT).

Instead, CGT will apply – and a taxable event will occur – when cryptocurrencies are disposed of in a non-DeFi transaction.

According to the hearing, a transaction must meet certain criteria to be considered a DeFi transaction.

In particular, it should involve the first transfer of crypto-assets from a lender to a borrower, or through a smart contract, where the borrower is obligated to return tokens.

In addition, the lender should have the right to withdraw the same amount of tokens originally lent or staked.

The goal 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 on participants, the new tax framework could treat all DeFi returns as income and charge a new miscellaneous income tax specifically for crypto-asset transactions.”

The consultation is the second phase of a five-step process, which will be followed by the drafting of legislation, implementation and monitoring, and finally, review and evaluation of the change.

Related: The UK includes crypto investments under the Investment Manager Exemption

The UK government took the first step in the process in July 2022 by asking for feedback on the taxation of crypto-asset loans and efforts within the framework of DeFi.

Simplifying the administrative process was again noted as the main goal as well as reducing costs for taxpayers participating in DeFi, while examining how tax treatment could better reflect the financial substance of these transactions.

Blade: Best and worst countries for crypto tax – plus crypto tax tips