Uniswap's affiliated organization responds to UK tax authorities: How should DeFi be taxed?
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Uniswap's affiliated organization responds to UK tax authorities: How should DeFi be taxed?
By minimizing administrative burdens on taxpayers and demonstrating the highest degree of clarity and simplicity, promote tax compliance.
Navigating Web3 tides with focused insightsCompiled | TaxDAO
DEF responded on June 22 to Her Majesty's Revenue and Customs (‘HMRC’) consultation on DeFi taxation:
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It aligns with the fundamental economic substance of typical DeFi transactions;
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It demonstrates maximum clarity and simplicity by minimizing taxpayer administrative burden to promote tax compliance;
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Its application should be flexible and comprehensive to accommodate future innovation;
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It uses standard market terminology to describe relevant tax obligations.
*TechFlow Note: DEF (DeFi Education Fund) is a non-profit organization created by the Uniswap team to fund education and research initiatives within the decentralized finance (DeFi) ecosystem. Established in 2021 with a $50 million donation from the Uniswap team, the fund supports long-term development in DeFi.
Summary of Key Issues
Question: Do rights received by lenders for lent or staked tokens have legal standing? Please answer this question with reference to any specific DeFi models you participate in, highlighting any legal uncertainties.
Regarding the correct characterization of "lender" rights, it must be emphasized that describing rights received by a "lender" for "lent" or "staked" tokens as having legal nature is inaccurate. There are two key reasons for this:
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In DeFi transactions, a user’s “counterparty” is typically a smart contract, making it difficult to identify legal relationships and determine against whom the “lender’s” rights could be enforced. Thus, establishing traditional legal frameworks for these relationships becomes complex and non-trivial due to the absence of a legally recognized “counterparty”;
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The core concept of DeFi aims to create a financial infrastructure where trust is established through software protocols rather than traditional legal relationships and mechanisms. Legal relationships are only necessary when operational reliance on human discretion is required—such as consumers trusting intermediaries to execute trades in traditional finance, or borrowers repaying loans. In contrast, DeFi operates on autonomous code (smart contracts) that function without intermediaries. Implying that such trust is established through legal means in DeFi would contradict its foundational innovation.
While we understand HMRC’s interest in determining whether transactions in the DeFi space should carry legally binding conditions or requirements, we believe this should not be their primary focus or requirement.
Although some may object to taxing transactions absent legal transfer of assets or creation/disposition of legal rights/obligations, we expect that HMRC’s desire to tax economic activity in DeFi should take precedence over technical legal characteristics. The essence of DeFi, both now and in its future evolution, revolves around eliminating reliance on legal structures to establish trust among parties.
If HMRC seeks to provide tax certainty only when clearly enforceable legal rights are established, a significant portion of the market will remain in uncertainty, potentially undermining HMRC’s ability to collect revenue from activities otherwise considered income-generating.
In most cases, the nature of rights arising from DeFi lending and staking arrangements may not align with traditional legal frameworks. The rights involved (if any) are more nuanced and not easily categorized within established legal concepts.
Therefore, HMRC should adopt a holistic approach that recognizes the unique characteristics of DeFi transactions. This will ensure fair and accurate assessment of the tax implications and treatment of wealth creation stemming from DeFi transactions.
Question: Do you support changing the rules so that DeFi returns are always treated as income in nature? What are the advantages and disadvantages?
Overall, we support changing the rules to default to treating DeFi returns as income in nature.
Advantages
Previous HMRC guidance placed the burden on taxpayers to determine whether DeFi returns should be treated as capital or income. By defaulting to treating DeFi returns as income, it provides individual taxpayers with greater clarity regarding the tax classification of their DeFi activities.
Corporate taxpayers are generally indifferent between income and capital treatment of DeFi returns.
Disadvantages
Treating DeFi returns as miscellaneous income may prevent individual taxpayers from using allowances that could offset tax liabilities on dividends and interest income. However, given the decentralized nature of DeFi “lending” and “staking,” we acknowledge the challenges in characterizing DeFi returns as interest, dividends, or royalties due to complexities related to source determination and withholding tax obligations.
Under the proposed DeFi tax regime, non-trading individual taxpayers who might otherwise receive capital treatment for DeFi returns would lose the benefit of currently lower CGT rates.
Possible Solution
The legislation could stipulate that DeFi returns are presumed to be miscellaneous income by default. However, if certain criteria are met, such returns could be treated as capital for individuals, with taxation deferred until contract termination or realization. These criteria could align with principles outlined in HMRC’s guidance at CRYPTO61214.
HMRC should consider introducing a separate allowance similar to the personal allowance for interest income. This approach would reduce administrative burdens for users engaging in small-scale transactions, balance tax benefits (via allowances) across DeFi returns, interest, and dividends, and signal the UK government’s commitment to maintaining its status as a leading global financial center.
Question: Do you anticipate users engaging in these and similar transactions facing any difficulties in determining the value of DeFi returns? If so, please provide examples where this could be an issue.
As a starting point, we encourage users to refer to HMRC’s guidance CRYPTO23000 on valuing cryptoassets for UK tax purposes. For reference, we include the following excerpts:
Many cryptoassets (such as Bitcoin) are traded on exchanges that do not use pounds sterling, so the value of any gain or loss must be converted into pounds for inclusion on a Self Assessment tax return.
Where a transaction has no sterling value (for example, where Bitcoin is exchanged for Ether), an appropriate exchange rate must be established to convert the transaction into pounds.
Reasonable care should be taken to use a consistent method for appropriate valuation of transactions. Details of the valuation method used should be retained.
Taxpayers need to determine the total assets received versus those deposited, and identify which portion of returned assets corresponds to the re-weighting of “staked” (LPed) assets and which tokens represent earned fees (DeFi returns).
Taxpayers need to establish the fiat value of assets at deposit and withdrawal. This presents challenges, and HMRC will need to clarify which fiat pricing data sources taxpayers should use when calculating tax liabilities.
For ease of administration, we recommend HMRC consider establishing an official list of exchange rates that users can reference when valuing their cryptoassets.
Question: What impact do you expect the proposals in this document to have on administrative burden and costs for DeFi users if implemented?
Overall, the proposals represent a positive step toward reducing administrative burden and costs for DeFi users and will promote compliance. Eliminating CGT implications for certain steps in the lifecycle of typical DeFi transactions (e.g., initial lending and staking of cryptoassets; and withdrawal or return of lent or staked tokens at term end) reflects the underlying economic ownership of liquidity providers.
Assuming DeFi transactions fall within the scope of the new DeFi tax rules, a “lender” would focus on three “tax events”:
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Receiving DeFi returns during the “lending” or “staking” period;
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Loss of “staked” or “lent” tokens due to borrower insolvency, which may trigger a taxable event;
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If the “lender” sells their “right” to the “lent” or “staked” tokens to another person.
Each of these events occurs periodically. Without accurate and automated methods to analyze transactions and report gains/losses or income under the proposed DeFi tax rules, the new framework will still impose significant administrative burden on users.
Reference:
https://www.defieducationfund.org/_files/ugd/84ba66_e73f5656c9a047788521cf09259db7a4.pdf
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