Following the publication of the guidance by HMRC in 2022, setting out its interpretation of how the law applies to cryptoasset loans and liquidity pool arrangements, some stakeholders raised concerns that there are situations where the tax treatments lead to disproportionate administrative burdens.
Evgeny Gokhberg, Founder of Re7 Capital, a UK-based DeFi investment firm focused on connecting real-world yields with decentralised finance markets posited that:
The UK’s proposed approach to DeFi lending and staking is a positive step for the country’s crypto ecosystem. By aligning tax treatment with the actual economic substance of DeFi activity, it provides greater predictability for institutional investors.
To explore the issue, the government ran a Call for evidence from 5 July 2022 to 31 August 2022 to seek views on the taxation of cryptoasset loans and liquidity pools. In addition to gathering information about the sector, it also invited views on 3 potential options of reform that could be considered.
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Option 1: to bring cryptoasset loans and liquidity pools within the repo and stock lending regimes by defining cryptoassets as securities for the purpose of those rules
Option 2: to create separate rules for cryptoasset loans and liquidity pools which follow the principles applicable to repos and stock lending
Option 3: to introduce new rules for cryptoasset loans and liquidity pools based on the NGNL principle, such that the disposal value is treated as matching the acquisition cost, which effectively defers the tax liability until the tokens are economically disposed of
Almost all respondents to the call for evidence advocated for a change of the tax rules applying to these transactions. However, most of them did not see Option 1 as an optimal solution.
Options 2 and 3 were favoured by similar numbers of respondents, but the administrative burden associated with Option 3 was raised as a potential concern by some respondents.
Cryptoassets, and the technology underpinning them, have developed rapidly over recent years and are now used in a wider range of transactions.
New forms of cryptoassets, and services that support their usage, continue to evolve at pace and are becoming more complex. The increase in the use of smart contracts to facilitate automatic transactions has increased the number of transactions and the complexity of the arrangements of individuals who use them.
The then government published a Call for Evidence in summer 2022 seeking data and views on the different potential options for the taxation of cryptoasset loans and liquidity pools.
This was then followed by a consultation from 27 April 2023 to 22 June 2023 on proposals to align the tax treatment of certain cryptoasset transactions more closely with their economic substance.
32 formal written responses to the consultation were received from a wide range of stakeholders, including individuals, businesses, tax professionals and representative bodies.
In addition, written responses to the consultation were supplemented by further engagement with stakeholders, through a series of roundtables and multilateral discussions.
Stakeholders unanimously supported HMRC looking at this issue. The key themes were that stakeholders wanted something that, compared to the current rules, would make compliance more straightforward and better reflect the economic reality of the transactions.
They also noted the need for any rules to be flexible enough to adapt to new arrangements that could emerge, and be wide enough to cover the main areas of the market. Some stakeholders raised concerns as to how HMRC was proposing to address the issue, and suggestions were made as to how the detailed design of the rules could be improved.
Following the consultation, HMRC has continued to have constructive, informal engagement with advisers and industry on how the design could be improved.
As a result, HMRC has been working to develop a potential approach where certain disposals are treated as ‘no gain, no loss’ (NGNL), and which could be extended to include automated market makers.
The government will continue to assess the merits of this potential approach, and the case for making legislative change to the rules governing the taxation of cryptoasset loans and liquidity pools.
The government wishes to thank all respondents and other interested parties for their constructive and continued engagement and valuable contributions.