UK Tax Authority Proposes Changes to Treatment of DeFi Lending, Staking

The U.K.'s tax authority is seeking public views on a proposed change to the tax treatment of decentralized finance (DeFi) lending and staking, according to a Thursday announcement.

HM Revenue and Customs' (HMRC) proposal follows a 2022 call for evidence. The authority cited recent crypto market failures, including the collapse of the FTX exchange, as cause for regulators' heightened interest in the sector.

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.

Under existing rules, DeFi transactions can be treated as disposals to be written off as gifts or sales by lenders or liquidity providers even in cases where ownership of the asset doesn't change.

"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."

The proposed changes would ensure DeFi transactions are not treated as a disposals for tax purposes. That would occur only when crypto assets are "economically disposed of in a non-DeFi transaction," the consultation said.

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.

Though the proposed framework is targeting DeFi lending and staking, it is also intended to apply for centralized finance (CeFi), where crypto lending or staking is conducted through intermediaries, the document said.

The HMRC has previously extended existing tax rules to crypto, including a tax break for foreign investors purchasing crypto through local agents.

The consultation is open for eight weeks and closes on June 22.

Read more: UK Extends Crypto Tax Break for Investment Managers in Financial Reforms

UPDATE (April 27, 13:55): Adds details starting in fourth paragraph.