DEFI taxation in the uk

Her Majesty’s Revenue and Customs (HMRC) unit opened today a public consultation in regards to how the proceeds earned by investors from decentralized finance (DeFi) initially should be taxed as part of the UK’s effort to become a crypto-friendly jurisdiction.

According to the announcement, all parties with direct involvement, understanding, and expertise in this particular field can submit their views on how DeFi should be taxed during the 8 weeks running from 5 July to 31 August 2022.

The statement outlines that the government is “interested in ascertaining whether administrative burdens and costs could be reduced for taxpayers engaging in this activity and whether the tax treatment can be better aligned with the underlying economics of the transactions involved”.

Also read: Best Crypto Tax Software: Top Solutions for 2022

This consultation is being pushed forward as part of the UK’s ongoing initiative to become a “global cryptoasset technology hub” – a goal that the government set forth on 4 April this year.

Back then, the government’s head of finance, Rishi Sunak, stated: “This is part of our plan to ensure the UK financial services industry is always at the forefront of technology and innovation”.

The HMRC stated that certain parties brought to their attention that there were circumstances in which the rules governing the country’s current Capital Gains Tax (CGT) were a bit inconsistent with the “substance of the [DeFi] activity”.

“We have been told that there are situations where the tax rules treat transactions as disposals where the effective economic ownership of cryptoassets is retained. This can lead to tax outcomes that do not reflect the economic effects, and to a tax liability from a transaction where no gain has been realised in a form which can be used to meet the liability”, the HMR stated.

DeFi Taxation is the Latest Hot Topic in The Race to Regulate Cryptos

Many developing countries appear to have accelerated the pace at which they are regulating this up-and-coming industry amid the collapse of several entities within the space including the debacle of Terraform Labs and its native tokens UST and LUNA – a situation that led to billions of dollars in losses for investors in multiple latitudes.

Stablecoins are one of the pressing subjects for legislators due to their large size and ability to disrupt the financial markets at a point when funds and financial institutions are increasing their exposure to the crypto market.

Also read: Crypto Tax UK Explained – Do You Pay Tax on Crypto Gains?

The HMRC’s views in regards to DeFi taxation refer to lending and staking operations specifically as those activities do not necessarily involve the transfer of an asset as blockchain-based protocols allow investors to earn money by locking up their digital assets in a similar way as a certificate of deposit (CD) but without having to give up ownership in the process.

The goal of regulators at this point is to bring clarity to the various transactions that take place within the ecosystem so “taxable events” can be easily identified. This would reduce the administrative burden of having to keep records and make complex calculations in a scenario where there is a lack of clarity.

According to the HMRC, failing to simplify how DeFi taxation works for the lay investor and even for institutions may deter these parties from participating and engaging in this evolving market.

The DeFi Winter is Here as Well

defi llama defi winter
Total Valued Locked (TVL) DeFi – Source: Defi Llama

The DeFi ecosystem has suffered from a shift in macroeconomic conditions and due to the collapse of several important projects such as the Anchor Protocol – a Terra-powered decentralized application that offered attractive yields for staking the ecosystem’s stablecoin UST.

Data from Defi Llama shows that the total value locked (TVL) within the ecosystem has dropped from a peak of around $250 billion back in December 2021 to just $75 billion at the moment. MakerDAO, AAVE, Curve Protocol, and UniSwap remain the largest applications by TVL.

In addition, the debacle of various exchanges due to their exposure to under-collateralized loans issued to entities that have defaulted lately has also prompted calls for further regulations in the space to protect investors’ money from weaknesses within the market’s critical infrastructure.

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