Original content published by our colleagues in BDO UK.
On 2 February 2022, HM Revenue and Customs (HMRC) issued guidance on how “De-fi” lending and staking is taxed from a UK tax perspective, which is welcome news.
The HMRC guidance is contained in the Cryptoasset tax manuals on HMRC’s website.
So, what is De-fi lending and staking?
In its simplest form, this is where a taxpayer either:
- Loans a cryptoasset that they currently own to a person or to a crypto platform for onward lending, or
- Where a taxpayer transfers crypto, they currently own to a crypto platform as a stake in return for a reward (staking).
In both instances (lending or staking) the taxpayer will receive some form of return - sometimes also referred to as a “reward”.
How are individuals involved in De-fi lending and staking taxed?
It is important to understand what the facts and circumstances are and whether you are acting as the lender or the borrower. Unlike cash loans, the borrower may also have a tax obligation on the transfer/disposal of crypto in satisfaction of the loan.
From a lender’s perspective, the starting point is determining whether they are trading or not. HMRC’s default position (which is aligned with their other crypto guidance) is that individuals are unlikely to be considered as trading when it comes to De-fi lending or staking although it is not impossible. For individuals who are not trading, the disposal/transfer of crypto under De-fi lending or staking arrangements is generally considered a disposal for capital gains tax purposes.
Depending on the facts, consideration may be required as to whether the disposal proceeds constitute deferred consideration (under the principle established in the Marren v Ingles case) to work out what is subject to tax upfront and what is taxed on a future receipt. A future payment of the original principle will generally be capital whereas the ‘reward’ element earned by the taxpayer for the lending/staking will generally be subject to income tax. It is worth noting here that the reward although similar to interest is not interest for tax purposes as HMRC do not consider crypto to be money and so would instead be taxed as miscellaneous income.
How are companies involved in De-fi lending and staking taxed?
As with individuals, the devil is in the detail to determine how De-fi/ staking transactions will be taxed for corporate lenders and borrowers. HMRC’s guidance re-emphasises its long-held view that cryptocurrencies are anything but currencies, rather they are ‘exchange tokens’ that are unlikely to fall within the intangible fixed asset or loan relationship regimes for corporation tax purposes. Again, the starting point for a corporate lender is to determine whether they are trading: however, unlike individuals the trading threshold for a company is lower and returns are more likely to be viewed as trading profits.
HMRC helpfully makes an analogy to trading in shares, securities, or financial products to determine whether a company is trading in cryptocurrencies - which means that there are a familiar set of case law tests can be drawn on. Where a corporate lender is not trading, the lending or staking of cryptocurrencies is likely to fall within the capital gains regime and follow the principles for non-trading individuals, set out above (i.e returns will be subject to the miscellaneous income provisions and repayment of principal subject to the capital gains rules).
A company carrying on both trading and non-trading activities in cryptocurrencies will need to carefully monitor the use of its cryptocurrencies as any change in the use of a cryptocurrency is likely to give rise to a dry tax charge: HMRC has confirmed that a market value charge would apply where cryptocurrencies switch from non-trading to trading purposes and vice a versa.
All clear?
While guidance on De-fi by HMRC is welcomed, the guidance also highlights the continued divergence in treatment for corporate tax, accounting, and legal purposes is likely to give rise to unexpected tax consequences.
The De-fi market (like all crypto markets) is fast paced, and there are different models of De-fi lending and staking currently offered. It is important to fully understand the facts of the scenario that you are dealing with before being able to establish the UK tax treatment. As always, taxpayers involved in such transactions should seek specialist advice on their tax treatment and how to report them on tax returns. HMRC are focused on how crypto is reported and taxed and so the onus of responsibility is with taxpayers to ensure that they get this right.
For help any advice from the crypto specialists at BDO please contact Moira McKeown, Senior Tax Manager.