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HMRC has updated its guidance on the taxation of income from pledges and debits made through the DeFi service.

Under the rules, the taxation of gains on these transactions depends on whether they are considered capital gains or income. The department acknowledges that classification can be a difficult task.

“Lending/pledging tokens through decentralized finance is an evolving field. As such, it is not possible to determine all the circumstances in which lenders/liquidity providers profit from their activities and the nature of those profits. Instead, a number of guiding principles have been developed,” the paper said.

HMRC first published guidance on the taxation of pledges in March 2021. At the time, the agency said that taxation depended on whether there was a "taxable trade" in the activity.

CryptoUK, the digital asset trading association, said the new rules make significant changes to the classification and tax treatment of DeFi.

HMRC has updated its guidance on the treatment of cryptocurrencies and digital assets, specifically for decentralised finance (DeFi) lending and pledging in the UK, significantly changing their classification and treatment. Full report and our response here – https://t.co/8XXD0bm34O pic.twitter.com/Q3N7La5FVX

– CryptoUK (@CryptoUKAssoc) February 2, 2022

Under the updated guidance, income may be considered capital gains or revenue based on a variety of factors, including.

  • Whether the amount of the proceeds was known at the time the agreement was entered into.
  • Whether the proceeds are paid periodically or upon repayment of principal.
  • Whether the loan term is short-term or long-term.

HMRC also notes the process of earnings realisation – if this occurs through the liquidation of major assets, it indicates an inflow of capital.

Based on this, CryptoUK suggests that HMRC could classify a transaction as a taxable alienation transaction when the token leaves the user's wallet to be borrowed or pledged on the DeFi platform. The association noted that the asset would still be subject to capital gains tax at this point, even though it remains in the user's possession and he wishes to return it in the future.

HMRC guidance also states that there may be other factors that determine the nature of the receipt and that all the facts of the transaction must be considered.

Ian Taylor, CEO of CryptoUK, said the new rules "add unnecessary reporting requirements and create confusion in terms of tax compliance."

Recall that in 2021, HMRC began collecting data about the customers of foreign cryptocurrency exchanges.

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