Changes to DeFi Lending and Staking Proposed by UK Tax Authority

UK HM Revenue and Customs proposes changes to DeFi lending and staking tax treatment to reduce risks and administrative burden.

The United Kingdom’s tax authority, HM Revenue and Customs (HMRC), proposed changes to the tax treatment of decentralized finance (DeFi) lending and staking. The proposed changes are open for public consultation until June 22, 2023, and aim to address the current tax treatment of DeFi transactions, which can lead to tax outcomes that do not reflect the underlying economic substance.

The HMRC cited recent crypto market failures, including the collapse of the FTX exchange, as cause for regulators’ heightened interest in the sector. Regulators worldwide have expressed concerns about DeFi’s risks, including cyber risks and other technical risks, as well as the increased dependencies between traditional and decentralized financial systems and a lack of backstops in periods of market stress.

The proposed changes aim to ensure that DeFi transactions in the UK are not treated as disposals for tax purposes unless the crypto assets are “economically disposed of in a non-DeFi transaction.” The current tax treatment of DeFi transactions as disposals leads to tax outcomes that do not reflect the underlying economic substance, and the need to determine and record the market value of assets at each step in the transaction can also give rise to a disproportionate administrative burden.

Implications to Crypto Lending & Staking

The proposed changes will also apply to crypto lending and staking through intermediaries, including centralized finance (CeFi), and could end up treating all DeFi returns as revenue in nature, subject to a “new miscellaneous income charge” to avoid administrative burdens. By doing so, the HMRC aims to reduce the risks associated with DeFi and CeFi.

The HMRC has previously extended existing tax rules to crypto, such as a tax break for foreign investors purchasing crypto through local agents. This latest proposal demonstrates the authority’s continued effort to keep up with the constantly evolving crypto market.

The proposed changes could significantly impact the taxation of DeFi transactions and, therefore, have a broader impact on the overall DeFi ecosystem. The changes aim to create a more favorable environment for DeFi development and investment, while also protecting investors and the broader financial system.

The consultation is an opportunity for the public to provide their views on the proposed changes to the tax treatment of DeFi lending and staking. The HMRC encourages all interested parties to participate in the consultation and share their thoughts on the proposed changes.