UK Revenue Guidance On Cryptoasset Lending And Staking Using Decentralised Finance — Tax

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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 used to 
deter­mine whether a trade is being car­ried on (or not) or whether, 
alter­na­tive­ly, the activ­i­ty which gen­er­ates the return falls 
out­side the scope of any trade. There is little 
cryp­toas­set-spe­cif­ic case law in the UK; as a gen­er­al observation, 
only delib­er­ate and orga­nized cryp­toas­set lend­ing and stak­ing is 
like­ly to con­sti­tute a trade.

If a trade is car­ried on, the cryp­toas­sets may be held as 
trad­ing stock. Where no trade is being car­ried on, or the activity 
falls out­side of the scope of trad­ing, the mak­ing of a DeFi loan or 
stak­ing (both involv­ing trans­fers of cryp­toas­sets) may be the 
dis­pos­al of a cap­i­tal asset, sub­ject to cap­i­tal gains tax for 
indi­vid­u­als and cor­po­ra­tion tax on charge­able gains for 
companies.

DeFi return: an income or capital receipt?

Any DeFi return is taxed in accor­dance with the receipt being of 
a cap­i­tal nature or rev­enue nature. A return of a cap­i­tal nature 
would be sub­ject to tax on the charge­able gain real­ized. Where the 
return has a rev­enue nature, the return might be taxed as trading 
income if (excep­tion­al­ly) the activ­i­ties are delib­er­ate and 
orga­nized enough, or (more like­ly) could be taxed with­in the scope 
of the mis­cel­la­neous income pro­vi­sions (in sec­tions 979–981, within 
Part 10 of the Cor­po­ra­tion Tax Act 2009).

HMRC note in their guid­ance that the nature of the return 
received by the lender or liq­uid­i­ty provider will depend on how the 
trans­ac­tion is struc­tured. The lend­ing or stak­ing of tokens through 
DeFi is acknowl­edged to be a rapid­ly evolv­ing area. Perhaps 
unsur­pris­ing­ly, HMRC set out “guid­ing prin­ci­ples” to 
assist with deter­mi­na­tion of the nature of the activ­i­ties being 
under­tak­en, cou­pled with sev­er­al exam­ples, instead of lay­ing out 
rules which are set in stone.

A key dis­tin­guish­ing ques­tion is stat­ed by HMRC to be whether 
the return earned by the lender or liq­uid­i­ty provider has resulted 
from the pro­vi­sion of a ser­vice to the bor­row­er of a DeFi lending 
plat­form. This might iden­ti­fy the return as being of a revenue 
nature. By con­trast, if the return was realised from the growth of 
an asset owned by the lender or liq­uid­i­ty provider, the treatment 
might be more com­pat­i­ble with a cap­i­tal return.

Com­pli­cat­ing fac­tors are list­ed in the HMRC guid­ance as being 
the var­i­ous DeFi oper­at­ing mod­els, includ­ing whether the return to 
be received by the lender/liquidity provider is known at the time 
the agree­ment is made (being sug­ges­tive of a rev­enue receipt), as 
opposed to a more spec­u­la­tive return (being sug­ges­tive, in 
HMR­C’s view, of a cap­i­tal receipt). The length of the peri­od of 
the lend­ing or stak­ing arrange­ment, any peri­od­i­cal nature of 
inter­im pay­ments and the link­ing of any return to the dis­pos­al of 
the tokens are all iden­ti­fied as addi­tion­al fac­tors to be taken 
into account. HMRC con­firm that this list is not exhaus­tive, and 
that no sin­gle fac­tor is determinative.

Examples and questions

The HMRC guid­ance includes a num­ber of worked exam­ples covering 
the treat­ment of cryp­toas­set dis­pos­als when loans are made, loan 
sat­is­fac­tion, and the tax posi­tion when a bor­row­er’s collateral 
is enforced or liq­ui­dat­ed. Fol­low­ing the exam­ples, and implementing 
the legal arrange­ments regard­ing DeFi in a tax con­text, is likely 
to lead to addi­tion­al ques­tions around com­pli­ance and 
inter­pre­ta­tion. This is per­haps par­tic­u­lar­ly so giv­en the fact that 
the UK case law which gov­erns the iden­ti­fi­ca­tion of a trade, and 
the nature of cap­i­tal and income receipts, is far from new. It will 
be inter­est­ing to see how well case law couched in terms of fruits 
and trees (Ryall v Hoare [1923], cited 
by HMRC in their guid­ance) fares when deal­ing with taxation 
ques­tions aris­ing from cryp­toas­sets and DeFi platforms.

The con­tent of this arti­cle is intend­ed to pro­vide a general 
guide to the sub­ject mat­ter. Spe­cial­ist advice should be sought 
about your spe­cif­ic circumstances.

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