HMRC updates its cryptoassets manual to address DeFi taxation in the UK

The UK’s HMRC has updated its cryptoassets manual that it published last year, to provide legislative clarification on how DeFi will be taxed in the UK. 

The cryptoassets manual is a formalisation of HMRC’s guidance which is updated as the cryptocurrency market expands and evolves. On 2 February 2022, Her Majesty’s Revenue and Customs updated its cryptocurrency manual to outline the tax treatment of decentralised finance, focusing on lending and staking.

According to the updated manual, and the section titled ‘Decentralised Finance: Lending and staking: Income tax: Making a DeFi loan: Nature of the return:

 “A person (“lender”) transfers the control of tokens to another person (“borrower”). At the time that transfer occurs, the lender acquires a right to demand that the borrower transfers to the lender the control of an equivalent quantity of tokens at a time in the future to satisfy the loan”. 

“A person (“liquidity provider”) transfers the control of tokens to a DeFi lending platform. This type of transaction may be termed “staking” or “providing liquidity”. At the time when the transfer occurs, the DeFi lending platform transfers control of one or more different tokens to the liquidity provider.”

At present there is no legislative framework for DeFi lending platforms which makes determining the tax consequences unclear. The update to the manual acknowledges this, and notes that the making and repayment of a DeFi loan/staking may make it a chargeable asset subject to Capital Gains Tax or, if it is part of the carrying on of a trade, subject to Income Tax.

In addition, the update notes “how the return (see CRYPTO61130) is taxed upon receipt by the lender/liquidity provider will depend on whether the return has the nature of capital or revenue”. 

Lavan Thasarathakumar Director of Regulatory Affairs EMEA at Global Digital Finance noted:

 “It is encouraging to see the UK responding quickly to the evolving space of DeFi and be one of the first to provide comment on this area. What is clear from this update is that a lot of work has gone into understanding how DeFi operates in order to provide some guidance as to how existing legislation will be applied in the eyes of HMRC. The update highlights that in certain circumstances there will be a lot of friction in the consumer journey in the DeFi lending space”

Thasarathakumar added:

“GDF has been in communication with HMRC on its update to the manual and will be inviting the community to a discussion with HMT to outline its concerns in due course.”

Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.