HM Revenue and Customs’ bold move on crypto-asset taxation is a popular one among industry members but there’s still a long way to go, say crypto tax experts.
HMRC launched a consultation on decentralised finance (DeFi) on April 27, requesting industry feedback on proposed legislation that would affect the way some crypto-asset transactions are taxed.
The proposed change would mean that DeFi transactions involving crypto-assets where the user retains the economic interest in the tokens locked away in the DeFi protocol would no longer be subject to capital gains tax (CGT).
Instead, under the proposed legislation, a transaction would only be subject to CGT when crypto-assets are “economically disposed of in a non-DeFi transaction”.
Fresh start
Dion Seymour, crypto and digital assets technical director at tax consultancy Andersen in London and former HMRC policy lead on crypto-assets, tells ITR that he expects feedback to be broadly positive.
“It has already been well received; we’re the first country to propose this kind of legislation, and it’s wanted,” he says.
Seymour argues that there are two camps at the moment, with one saying that the consultation doesn’t go far enough and that more needs to happen.
“People want a broader tax regime for crypto, but no one articulates what that would look like.
“The other camp – in a climate where the policy approach to crypto-assets in the US and other nations creates confusion – will be happy to see steps from the government towards something clear and positive,” says Seymour.
Even those who don’t believe enough has been done will still welcome the proposed DeFi legislation as a starting point because it signals a change in the way crypto legislation is made, says James Cherry, associate at international law firm Simmons & Simmons based in London.
“Overall, the proposed DeFi consultation is to be welcomed as the UK government is looking to introduce bespoke UK legislation tailored to the distinct nature of the crypto-asset market.”
This is a huge step away from the previous approach which, he says, was attempting to deal with crypto transactions within the scope of existing provisions.
Until now, crypto has been seen as having been neglected and not dealt with as an independent sector that needs its own tailored legislation.
“HMRC has [previously] tried to shoehorn the taxation of crypto into existing legislation that is not fit for purpose for this emerging new asset class,” says Louise Lane, head of crypto tax at UK-based chartered accountant Wright Vigar.
The creation of bespoke legislation for crypto transactions is set to provide a “clean slate” from which to build effective policy, says Lane.
Level playing field
The UK’s tax administration has said it would like to hear from investors, professionals and firms engaged in DeFi activities as part of the consultation.
HMRC has also said that it will consider in-person consultation meetings on the proposed changes depending on the feedback received.
Currently, tax rules treat crypto transactions differently to other more traditional types of investment activity like shares. Tax directors have been calling on HMRC to create a more equal playing field for some time.
“The position of the consultation is sensible because other sectors like banking have the ability to conduct transactions without friction; crypto is treated slightly differently,” says Seymour.
“It was recognised by HMRC that the economic substance of crypto transactions wasn’t necessarily a good reflection of the activity,” he adds.
HMRC’s stated reasoning behind the proposal is that crypto-asset DeFi transactions – specifically lending and staking – need to be taxed in a way that better reflects their nature, “whilst reducing the administrative burden on users”.
Long way to go
The proposal marks the beginning of HMRC’s attempt to create a specific crypto tax framework that seeks to bridge the gap between the tax burden faced by crypto transactions and traditional activities.
Although DeFi is a large area in crypto, there’s still a lot more ground to cover.
In March 2022 the Bank of England noted that the interaction between crypto and traditional markets will expand to new legislative areas that will need to be addressed.
“This is a big first step on a long journey and we need a lot more, but it’s good to see HMRC engaging with crypto in this way,” says Lane.
“DeFi is a significant aspect of crypto activity, however, there are so many other aspects which we still have little to no guidance on.”
In the meantime, further scrutiny is necessary because of the potential gaps that remain in the proposed legislation.
Cherry notes that an example of this scrutiny will arise as industry members seek to “ensure that certain novel and multilateral transactions do not inadvertently fall outside the scope of the proposed regime”.
The proposed DeFi legislation is clearly considered to be a good place to start, but it’s by no means complete. We will have to wait and see what the consultation, ending on June 22, will reveal about what stakeholders think.
According to Seymour, it is also worth remembering that this is just a consultation and that the government always has the unwritten final option of “do nothing”.
Tax advisers will be hoping the opposite is true and that HMRC doesn’t pull the plug on legislation that they say marks the beginning of much-needed change.
