In early February, HMRC published a new chapter in its Cryptoassets Manual dealing with decentralised finance (“DeFi”). DeFi is an umbrella term encompassing a range of products which are comparable with traditional financial services. DeFi platforms can provide services such as decentralised exchanges, saving, lending and derivatives, using distributed ledger technology.
HMRC’s guidance focuses on the taxation of “lending” and “staking” services which are entered into between unconnected lenders and borrowers through a DeFi platform.
“Lending” in this context occurs when a person transfers crypto-tokens to another person. The transfer results in the recipient (a “borrower”) taking control of the tokens. The “lender” acquires a right to demand the transfer, in return, of a determined quantity of tokens to satisfy the “loan” at some point in the future.
“Staking” occurs when a person transfers control of tokens to a DeFi lending platform. The transferor, also known as a “liquidity provider,” receives one or more different tokens from the DeFi lending platform in return. The tokens which have been transferred to the DeFi lending platform by the liquidity provider can be transferred by the platform to third party “borrowers.” That “borrower” is required, at a future date, to provide a return to the DeFi lending platform, all or part of which is passed on to the liquidity provider.
These arrangements might appear to have certain familiar hallmarks of collateralized lending transactions outside the cryptoasset sector. Elements of the arrangements are familiar to observers of peer-to-peer financing arrangements, or stock lending transactions. However, given the unique form of cryptoassets as, in the view of HMRC, not constituting “money” or “currency,” the treatment of the rate of return on the “lending” and “staking” does not constitute “interest” for UK tax purposes.
Accordingly, HMRC follow a different approach to the taxation of lending and staking of cryptoassets to the way in which, for example, loan relationships or deemed loan relationships might be taxed in the UK. The provisions in UK tax legislation for taxing loan relationships (and deemed loan relationships) therefore do not apply to cryptoassets.
How any DeFi return is taxed when arising to the lender and liquidity provider will depend, for both income tax and corporation tax purposes, on whether the activity amounts to a trade, and whether any return produced has the nature of being a capital receipt or a revenue receipt.
Trading or investing?
The HMRC guidance states that the relevant considerations to be made when determining whether a trade is being carried on involving the making of DeFi loans would be similar to those made when considering whether there is a trade in shares, securities and other financial products. This leads tax practitioners to the familiar, but complicated, case law analysis being…
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