UK Tax Watchdog Reveals New Framework for DeFi Services

The United Kingdom’s top tax authority published a consultation paper on Thursday, proposing a new taxation framework for decentralized finance (DeFi) transactions. The regulator says DeFi services must not be treated as disposals for tax purposes except for exceptional cases.

UK Tax Regulator DeFi Transactions Should Not Be Treated as Disposals

HM Revenue and Customs (HMRC), the UK’s tax, customs, and payment authority, released a document on Thursday proposing several critical changes to how DeFI lending and staking services are treated for tax purposes in the country. The consultation paper, now open for public consultation, said the proposed changes would also apply to crypto lending and staking through intermediaries.

The move comes because the HMRC believes that current tax rules can treat DeFi-related transactions as disposals, meaning they can be written off as gifts or sales by lending firms or liquidity providers even if asset ownership remains unchanged. Such treatment “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,” HMRC wrote in the 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.”

– HMRC said in the proposal.

For that reason, the HMRC proposed changes to ensure DeFi transactions are not treated as disposals by tax authorities, except for when cryptocurrencies are economically disposed of in a non-DeFi transaction. While the proposal primarily focuses on DeFi lending and staking services, it could also apply to centralized finance (CeFi) transactions, the consultation document said, where such services are executed through middlemen.

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2022 Collapses Turn Regulators’ Attention Toward DeFi

HMRC’s calls for a new tax framework come after a severe market downturn that exposed many crypto and DeFi-related risks in the past year. The tax authority said that recent high-profile collapses, such as the FTX, are among the main reasons behind global regulators’ growing interest in the sector.

Regulators have shown interest in DeFi, with global policymakers pointing out specific cyber-related and other technical risks in the nascent sector. In addition, DeFi has been said to lack backstops during periods of market turmoil, while dependencies between traditional and decentralized financial systems remain high.

Research reports in December revealed that DeFi accounted for $3 billion, 80% of all stolen crypto funds last year.

Do you agree that DeFi services should be treated differently regarding taxation? Let us know in the comments below.