UK Tax Authority Proposes Changes to Treatment of DeFi Lending

UK Tax Authority Proposes Changes to Treatment of DeFi Lending – According to an announcement made on Thursday, the tax authority of the United Kingdom is requesting feedback from the public regarding a potential alteration to the taxation approach for lending and staking in decentralized finance (DeFi). The proposal by HM Revenue and Customs (HMRC) comes after a call for evidence in 2022, with the authority referring to recent crypto market setbacks, such as the FTX exchange’s downfall, as a reason for regulators to have a greater interest in the industry.

Regulators around the world have cast their eyes on DeFi, and policymakers have “highlighted specific risks including cyber risks and other technical risks, as well as increased dependencies between traditional and decentralized financial systems and a lack of backstops in periods of market stress,” HMRC said. Currently, DeFi transactions can be considered disposals and be recorded as either gifts or sales by lenders or liquidity providers, even if the asset’s ownership remains unchanged, according to the current regulations.

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“This can lead to tax outcomes that do not reflect the underlying economic substance, and to a tax liability from a transaction where no gain has been realized in a form which can be used to meet the liability,” according to the consultation document. “The need to determine and record the market value of assets at each step in the transaction may also give rise to a disproportionate administrative burden.” As per the proposed modifications, DeFi transactions would not be treated as disposals for tax purposes, and such treatment would only be applied when crypto assets are “economically disposed of in a non-DeFi transaction,” as stated in the consultation.

The new framework could also end up treating “all DeFi returns as being revenue in nature,” and subject to a “new miscellaneous income charge,” to avoid administrative burdens. The proposed structure, while focusing on DeFi lending and staking, is also designed to be relevant for centralized finance (CeFi), where lending or staking of cryptocurrency is facilitated through intermediaries, according to the document.

HMRC has previously extended the current tax regulations to crypto, such as a tax exemption for foreign investors buying cryptocurrency through local agents.

The consultation period will be open for eight weeks and will conclude on June 22.


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