Beginning of a long crypto journey for HMRC is the DeFi consultation

According to experts, HMRC's proposed crypto-asset DeFi law is a fine place to start, but more work is required to create a comprehensive framework for crypto taxation.

Industry participants support HM Revenue and Customs' courageous approach on crypto-asset taxes, but there is still much work to be done, according to specialists in the field.

On April 27, HMRC released a consultation on decentralized finance (DeFi), asking the sector for input on proposed legislation that would change how some transactions using crypto-assets are taxed.

With the proposed change, capital gains tax (CGT) would no longer apply to DeFi transactions involving crypto-assets where the user retains the economic interest in the tokens locked away in the DeFi protocol.

As opposed to this, the proposed legislation would only apply CGT to transactions that "economically dispose of [crypto]assets in a non-DeFi transaction."

Dion Seymour, crypto and digital assets technical director at tax advisory firm Andersen in London and a former HMRC policy lead on crypto-assets, says that he anticipates comments will be largely favorable.

"It has already been well received; we’re the first country to propose this kind of legislation, and it’s wanted," he claims.

According to Seymour, there are currently two factions, one of which believes that the consultation doesn't go far enough and that additional action is necessary.

"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," Seymour continues.

According to James Cherry, associate at global law firm Simmons & Simmons based in London, even those who don't think enough has been done would support the proposed DeFi legislation as a starting point because it represents a change in the way crypto legislation is drafted.

"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."

He claims that this is a significant improvement over the prior strategy, which focused on addressing cryptocurrency transactions within the ambit of current laws.

Cryptocurrency has previously been viewed as having been disregarded and untreated as a separate industry in need of specially crafted legislation.

According to Louise Lane, head of crypto tax at UK-based chartered accountant Wright Vigar, "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."

According to Lane, the development of specific legislation for cryptocurrency transactions will offer a "clean slate" on which to base successful policies.

The UK's tax administration has stated that as part of the consultation, it would like to hear from investors, experts, and businesses involved in DeFi operations.

In addition, HMRC stated that depending on the response it receives, it may consider holding in-person consultation sessions on the suggested changes.

Tax laws now regard cryptocurrency transactions differently than other, more conventional investing activities like stock trading. Tax directors have long urged HMRC to establish more even playing fields.

According to Seymour, "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."

He continues, "It was recognised by HMRC that the economic substance of crypto transactions wasn’t necessarily a good reflection of the activity."

The proposal's claimed justification by HMRC is that crypto-asset DeFi transactions, particularly lending and staking, must be taxed in a way that better reflects their nature, "whilst reducing the administrative burden on users."

The proposal is the first step in HMRC's effort to develop a unique crypto tax system that aims to close the taxation gap between traditional activities and cryptocurrency transactions.

There is still a lot of ground to cover, even though DeFi is a sizable section of cryptocurrency.

The link between cryptocurrency and regular markets will broaden to new legislative areas that will need to be addressed, the Bank of England noted in March 2022.

"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."

Further scrutiny is required in the interim due to the potential loopholes in the legislation as it is now written.

One instance of this examination, according to Cherry, will occur as industry participants strive to "ensure that certain novel and multilateral transactions do not inadvertently fall outside the scope of the proposed regime."

There is little doubt that the proposed DeFi law is a fine place to begin, but it is by no means comprehensive. We'll just have to wait and see what the consultation, which ends on June 22, reveals about the opinions of the stakeholders.

In addition, Seymour says it's important to keep in mind that this is only a consultation and that the government always has the unwritten right to "do nothing" in the end.

The legislation, which tax advisors claim is the start of much-needed change, will be put on hold by HMRC if the opposite occurs, they hope.

By fLEXI tEAM