Taxation of Decentralised Finance Call for Evidence: Simmons response

Simmons has submitted a response to HMRC’s Call for Evidence on the tax treatment of decentralised finance (DeFi).

In summary, the purpose of the call for evidence is to obtain more information about how the tax treatment impacts DeFi activities and to inform the government’s options for reducing the administrative complexity for taxpayers arising from the application of current tax law.

Under the current law, the tax treatment of the lending/staking of cryptoassets and the repayment/withdrawal will depend on whether there is a transfer of beneficial ownership. If there is, then there will be a disposal for capital gains tax (or corporation tax) purposes with a potential tax charge. Moreover, 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’s current guidance indicates that the lending or staking of cryptoassets to a DeFi platform in return for other tokens received from the DeFi platform will generally give rise to a disposal for tax purposes where the lender/transferor if the lender/transferor has transferred beneficial interest in their tokens. The same analysis would apply to a borrower who provides tokens as collateral for a loan. However, this analysis attracted criticism as it potentially leads to a tax charge in circumstances where the lender/transferor does not receive any return at the time of the disposal (a so-called dry tax charge). For further information, see our Insights article discussing HMRC’s DeFi Guidance.

In an effort to reduce administrative burdens and costs for taxpayers, and to better align the tax treatment with the underlying economics of the transactions involved, HMRC requested feedback on three possible options:

1. Amending the Stock and Repo Regime to include Cryptoassets (‘Option 1’);

2. Create separate rules for DeFi lending and staking activities mirroring the principles applicable to repos and stock lending (‘Option 2’); and

3. Treating the transfer of cryptoassets for lending and staking as a ‘no gain no loss’ transaction, by treating the disposal value as matching the acquisition cost (‘Option 3’).

In our response, we posited that HMRC’s ‘Option 2’ would provide the best foundation for a model which will on a timely basis, protect and not discriminate against current existing financial markets, and allow the DeFi industry to thrive in the UK. Broadly speaking, the “no disposal” principles from Sections 263A and 263B Taxation of Chargeable Gains Act 1992 could operate as a model for new rules relating to DeFi transactions, taking into account that lending and staking activities do not as a matter of economic substance involve disposals of digital assets. However, we noted that careful consideration should be given to adapt these rules to reflect the nature of DeFi transactions including:

1. the nuances and fast development of DeFi transactions and digital assets generally which will require careful drafting to ensure current and novel transactions do not inadvertently fall outside any new rules; and

2. that DeFi transactions are not necessarily bilateral transactions. The increasing sophistication and deployment of smart contracts have created a variety of structured transactions which will require HMRC to undertake careful analysis of the market.

If you have questions in respect of the response, and the next stages in the consultation, please feel free to contact us.