In yet another development for the UK cryptocurrency sector, on 5 July 2022 the UK Government announced a consultation as to the taxation of cryptoasset loans and “staking” within the context of decentralised finance (“DeFi”). In particular, the UK Government is interested in ascertaining whether administrative burdens and costs could be reduced for taxpayers engaging in DeFi lending and staking as well as seeking to understand whether the tax treatment of such activities can be better aligned with the underlying economics of the transactions involved.

DeFi lending and staking encompass a range of activities that reward users who deposit cryptoasset tokens into a pool or lend them to other individuals or platforms for a certain period to earn passive income returns often described as interest. The UK Government has previously published guidance dealing with DeFi (previously covered here).

HMRC understand that there may be circumstances in which the current tax rules treat transactions as disposals where the effective economic ownership of the cryptoassets is retained. This position can lead to tax consequences that are not aligned with the economic effects of the transaction and may also give rise to a “dry tax charge” where a tax liability arises but no gain has been realised in a form that can be used to meet the liability.

The scope of the consultation is limited to the tax treatment for investors participating in DeFi lending and staking and expressly excludes transactions entered into by individuals or entities as part of a trade, such as running a platform.

Under the consultation, HMRC is considering three possible options to ensure that the taxation of DeFi lending and staking corresponds with the economic reality of the transaction whilst not causing market distortions by incentivising participants to favour one activity or asset over another. These three options can be summarised as follows:

• Option 1: Bring DeFi lending and staking within the UK’s current “repo and stock lending rules” by defining cryptoassets as “securities”;
• Option 2: Create separate rules for DeFi lending and staking, similar to the UK’s current “repo and stock lending rules”;
• Option 3: Apply a “no loss no gain” treatment to DeFi lending and staking so that any tax liability would be deferred until the assets are economically disposed of.

HMRC are seeking to understand the suitability of each option together with the pros and cons for each option. In addition, HMRC have asked for specific feedback in relation to alternative approaches that have been adopted by other jurisdictions or other options that should be considered.

The consultation will close on 31 August 2022.