UK HMRC has updated its handbook on cryptocurrency assets published last year to provide legislative clarification on how DeFi will be taxed in the UK.

The Cryptocurrency Assets Handbook is the official form of HMRC's guidance, updated as the cryptocurrency market expands and evolves. On February 2, 2022, HM Revenue and Customs updated its cryptocurrency handbook to outline the tax treatment of decentralized finance, focusing on lending and pledging.

According to the updated brochure, and the section titled "Decentralized Finance: Lending and Pledging: Income Tax: Making DeFi Loans: The Nature of the Return".

"One person (the "Lender") transfers control of the tokens to another person (the "Borrower"). At the time the transfer occurs, the Lender has the right to require the Borrower to transfer control of an equal amount of tokens to the Lender at one time in the future to repay the loan."

"A person (the "liquidity provider") transfers control of a token to the DeFi lending platform. This type of transaction may be referred to as a "pledge" or "provision of liquidity". When the transfer occurs, the DeFi Lending Platform transfers control of one or more different tokens to the liquidity provider."

There is currently no legislative framework for DeFi lending platforms, which makes the determination of the tax consequences unclear. The manual update acknowledges this and states that the origination and repayment of a DeFi loan/pledge may make it a taxable asset subject to capital gains tax or, if it is part of the transaction carried out, income tax.

In addition, the update states that "the taxation of the return received by the lender/liquidity provider (see CRYPTO 61130) will depend on whether the return is of a capital or income nature".

Lavan Thasarathakumar, Director of Regulatory Affairs at Global Digital Finance EMEA, stated.

"It is encouraging that the UK has responded quickly to the evolving space of DeFi and has been one of the first countries to comment on this area. It is clear from this update that a great deal of work has been done to understand how DeFi works in order to provide some guidance on how to apply existing legislation in the eyes of HMRC. This update highlights that in some cases, there is a lot of friction in the consumer journey in the DeFi lending space"

Thasarathakumar adds.

"GDF has been in communication with HMRC regarding updates to the handbook and will be inviting the community to discuss with HMT to outline its concerns in due course."

Disclaimer: This article is for informational purposes only. It is not provided or intended to be used as legal, tax, investment, financial or other advice.